Optimal bail out policy, conditionality and constructive ambiguity

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• dc.contributor.author Freixas, Xavierca
• dc.contributor.other Universitat Pompeu Fabra. Departament d'Economia i Empresa
• dc.date.accessioned 2017-07-26T10:50:16Z
• dc.date.available 2017-07-26T10:50:16Z
• dc.date.issued 1999-06-01
• dc.date.modified 2017-07-23T02:04:41Z
• dc.description.abstract This paper addresses the issue of the optimal behaviour of the Lender of Last Resort (LOLR) in its microeconomic role regarding individual financial institutions in distress. It has been argued that the LOLR should not intervene at the microeconomic level and let any defaulting institution face the market discipline, as it will be confronted with the consequences of the risks it has taken. By considering a simple cost benefit analysis we show that this position may lack a sufficient foundation. We establish that, instead, uder reasonable assumptions, the optimal policy has to be conditional on the amount of uninsured debt issued by the defaulting bank. Yet in equilibrium, because the rescue policy is costly, the LOLR will not rescue all the banks that fulfill the uninsured debt requirement condition, but will follow a mixed strategy. This we interpret as the confirmation of the "creative ambiguity" principle, perfectly in line with the central bankers claim that it is efficient for them to have discretion in lending to individual institutions. Alternatively, in other cases, when the social cost of a bank's bankruptcy is too high, it is optimal for the LOLR to bail out the insititution, and this gives support to the "too big to fail" policy.
• dc.format.mimetype application/pdfca
• dc.identifier https://econ-papers.upf.edu/ca/paper.php?id=400
• dc.identifier.uri http://hdl.handle.net/10230/330
• dc.language.iso eng
• dc.relation.ispartofseries Economics and Business Working Papers Series; 400
• dc.rights L'accés als continguts d'aquest document queda condicionat a l'acceptació de les condicions d'ús establertes per la següent llicència Creative Commons
• dc.rights.accessRights info:eu-repo/semantics/openAccess
• dc.rights.uri http://creativecommons.org/licenses/by-nc-nd/3.0/es/
• dc.subject.keyword banks
• dc.subject.keyword bail-out
• dc.subject.keyword lender of last resort
• dc.subject.keyword constructive ambiguity
• dc.subject.keyword Finance and Accounting
• dc.title Optimal bail out policy, conditionality and constructive ambiguityca
• dc.type info:eu-repo/semantics/workingPaper